What exactly does the IRS’ new crypto guidance mean?
Earlier this month, the Internal Revenue Service (IRS) released new tax guidance that expands upon its previous 2014 notice. This fresh update brings us new details on hard forks, among other things, in a 5-page pdf Revenue Ruling 2019-24 and a set of frequently asked questions (FAQs).
While this update marks a big step forward in the IRS addressing the gray areas of its earlier guidance, the big question is still what the new tax guidance means for the crypto industry. So, here are a few relevant points from the document to consider.
IRS guidance and crypto adoption
The IRS' new guidance has helped solidify the definition of cryptocurrency, as well as two other terms: "hard fork" and "airdrop." This effort should be well-received, as it seeks to disambiguate the use and application of virtual currencies and convertible virtual currencies, as first indicated in the 2014 notice.
This move is a net benefit to crypto, as it adds to the growing legitimization and reputation of cryptocurrencies in the financial sector. On top of this, if IRS guidance makes preparing you crypto taxes easier, it could help promote the mainstream adoption of cryptocurrencies by businesses.
The not so good
The IRS has reiterated that you trigger capital gains or loss every time you pay for goods and services, even for something as small as a coffee. There is no such thing as a "de minimis" exemption. The same applies when you earn crypto as a salary or receive it as payment for service.
The latter isn't as bad as the former, as crypto adoption could be advantageous if people were able to use virtual currencies for everyday purchases without the worry of triggering taxable events.
Gifts and donations
If you receive cryptocurrency as a gift, it will not be considered income at that time, rather only when you then sell, exchange, or dispose of it. Here, the basis for capital gains or losses is equal to your benefactor's basis or the lesser of your donor's basis or the cryptocurrency's fair market value at the time of receiving the gift.
Donating crypto to a charitable organization generates no income, or capital gain/loss. For those who held the crypto for over a year, they get to deduct an amount, at fair market value of the donated currency. On the other hand, for a holding period of less than a year, deductions would be the lesser of the donor's basis or the fair market value of the donated cryptocurrency at the time the donation was made. The basis has to be calculated using FIFO or Spec ID.
Overall, there is a lot to digest from the new guidance, and more is sure to come out as the crypto community absorbs everything. But what exactly does the new guidance mean for the crypto industry? Let’s address two points specifically.
Cryptocurrency traders can no longer evade taxes
The key point to take away is that the IRS is allowing no room for non-compliance.
According to IRS Commissioner, Chuck Rettig, the main goal is to "help taxpayers understand the reporting requirements." But also notes that the IRS is taking steps to enforce the country's tax laws, especially in cases where taxpayers fail to, or simply don't want to, follow the rules.
The events of July-August, with over 10,000 taxpayers receiving letters from the tax body, made this abundantly clear. And in its press release, the IRS repeated that it has information on taxpayers who have misreported their crypto transactions or who haven't reported crypto income and thus dodged paying capital gains taxes.
The IRS’ responses in their FAQs elaborate that taxpayers should keep all the necessary records to be able to file their tax returns correctly. You must hold onto all documents related to crypto receipts, sales, and exchanges or such other crypto dispositions.
The new guidance may be to educate the taxpayer, but it's also the foundation upon which the IRS will tackle audits and criminal prosecution.
"Airdropped" coins are a bit of a controversy
According to IRS guidance, receiving "airdropped" coins constitutes income, which is, therefore, taxable. If you receive an airdrop, then its basis is the fair market value at the time you received it.
Here is what the IRS specifically says;
"If a hard fork is followed by airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive that cryptocurrency."
However, this raises yet another problem: If you were to receive an airdrop for a coin you didn't ask for - that would also be taxable income even if you later struggle to liquidate it!
Take the example of Bitcoin SV, which thousands of people got following the Bitcoin Cash (BCH) hard fork in 2018. What does it mean to taxpayers who are now holding taxable income from a coin with no liquidity and which can't be disposed of easily?
The Bottom Line
Crypto is here to stay, and whether you like it or not, so is crypto regulation and taxation. What to take away from this new guidance is that the IRS is preparing itself for a hard wave of crypto tax enforcement. If the crypto tax regulations still seem a little daunting, you might want to hire a bitcoin tax accountant. While it may result in some upfront expenses, it will probably save you more money in the long run.
Robin Singh is the co-founder and CEO of Koinly.io - a cryptocurrency accountancy and tax reporting platform that automatically generates capital gains reports for USA, UK, Australia, Ireland and other countries.